On 10 May 2023, the Department for Business and Trade published “Smarter Regulation to Grow the Economy”: a high-level policy paper and the first in what is intended to be a series of regulatory reform announcements.

The paper sets out the Government’s desire to use the UK’s regulatory decoupling from the EU to bring forth new proposals that, if implemented, are intended to drive economic growth. Regardless of their economic impact, the measures highlighted would mean significant changes to UK employment law. You can read more about the range of measures here.

Upon initial review, one measure stands out from a business protection perspective: a proposal to introduce legislation capping the duration of non-complete restrictive covenants at three months post-termination of employment.

This note will provide a short refresher on the current legal framework for non-compete restrictions in employment contracts, before considering what this change would mean for businesses.

How non-compete clauses are used now

Currently, post-termination non-compete clauses in employment contracts are one of the most restrictive forms of business protection devices that employers can utilise.

Such provisions can be used to prevent an employee, following the conclusion of their employment, creating, having a material interest in, and/or being an employee (or other stakeholder) of a business which competes with their former employer. This means affected employees will often be prevented from taking jobs with competitors in specific sectors, usually for periods of up to around 12 months (for the most senior executives). The Government has identified the use of lengthy non-competes as a considerable impediment to and disincentive on worker-mobility and talent acquisition.

As there is currently no legislative framework regulating restrictive covenants, it is open to employers to decide on the scope and duration of post-termination restrictions in their contracts of employment. However, through a series of judgements, courts have limited the ability of employers to enforce such clauses in certain situations and provided clear guidance on the applicable tests. The following principles will be used by the courts in assessing whether to allow such provisions to be enforced:

  • Whether the employer needs the provision to protect a legitimate proprietary interest;
  • Whether the provision is reasonable given the interests of the parties, and the wider public;
  • Whether the purpose of the clause is not just to prevent competition. A non-competition restriction must also be designed to protect the employer's confidential information, trade secrets or customer connections, and to prevent the employee from obtaining an unfair advantage by exploiting these; and
  • Whether the restriction is any wider than necessary to achieve its purpose.

Against that backdrop, courts have only been likely to enforce such provisions when:

  • The legitimate proprietary interests of the business could not realistically be protected using less demanding alternative restrictive covenants. This may be in the case where a trade secret could not be protected by confidentiality provisions alone; and
  • The employee concerned has such a position or reputation with the clients or suppliers of the business that the only effective protection of their business would be to ensure they do not compete.

Non-compete clauses are often also used in the commercial context whether in a business transfer or share purchase (as well as in partnership agreements). Restrictive covenants in employment contracts are generally viewed more strictly than those in transactional/commercial contracts where it is assumed commercial parties will be bargaining from more equal positions. It is therefore foreseeable that incoming regulatory reform will differentiate between these scenarios and will not cover commercial contexts (the Government has clearly referred to employment contracts and employees (rather than, for example, shareholders)). However, we will keep a watchful eye on this point given its significance.

Changes to non-compete clauses

The policy paper outlines a new restriction on post-termination non-compete provisions which would cap the length of such restrictions at a maximum of three months after termination of employment: a significant shortening on the periods often used in contracts at the moment. Further details on the terms of this restriction are not spelt out but the Government states that they will be consulting further on their proposals going forward.

The Government is clear that this change will not interfere with other restrictive covenants in employment contracts including the ability of employers to utilise paid notice periods, gardening leave, non-solicitation clauses, and confidentiality provisions. Further, as outlined above, the wording of the announcement strongly suggests changes will be focused on the employment context and are unlikely to also be extended to the use of similar clauses in transactional documentation such as share purchase agreements and investor agreements.

Non-compete clauses in other jurisdictions

While non-compete clauses are common in other jurisdictions, national regulation varies significantly. While the UK have only published intentions to legislate for the changes detailed above, it is worth being mindful of the provisions enacted elsewhere as this may inform the direction of travel of this government, or a future government with a different political makeup and a more employee-friendly disposition.

Currently in Germany, non-compete clauses are only enforceable if the affected employee is compensated with at least 50 per cent of the remuneration received during their employment for the term of the restriction. While this can potentially be offset if the employee goes on to earn a salary elsewhere within the term, this places a significant premium on such clause’s use.

Similarly, in Italy, non-compete clauses can only be enforced with a specific compensation attached which case law shows must be fair and adequate. In France, a fee is also due and the sum must be adequate in the circumstances. While neither jurisdiction enforces a three month time limit, such provisions are restricted to a lifetime of one or two years.

In the United States, following an Executive Order by President Joe Biden in 2021, the Federal Trade Commission (FCT) has proposed a ban on non-compete clauses between employers and employees. While currently such clauses are restricted in only a handful of states, the FCT would prohibit them across the country at a federal level. It is notable, however, that the proposed ban has an exemption for buyers and sellers of a business where the seller held 25 per cent or more of the shareholdings. This may well reflect the approach that the UK Government will take to non-compete clauses in the distinct commercial context.

What this means for businesses

Ultimately, this policy paper only marks the Government’s future direction and non-compete clauses in employment contracts remain subject only to the restrictions set out in case law. The Government did not commit to a timescale for the reforms and other competing political priorities may come to consume the Government’s time.

However, it would be prudent at this stage to start thinking about your current suite of restrictive covenants for key employees, and whether going forward you may wish to rely more heavily on other restrictions which are unaffected by these proposals, including garden leave and non-dealing/non-solicitation clauses (which will become of critical importance if these changes to non-competes are implemented).

Further detail would also be needed as to whether those employees currently bound by existing covenants would have their non-competes reduced to three months’ duration, or alternatively whether the legislation would not apply retrospectively (this would seem a difficult policy decision to maintain).

In a deal context, the notice, garden leave and post-termination restriction clauses of senior management and executive directors will be scrutinised even more closely as part of due diligence exercises on acquisition and investment, with consideration being given to appropriate protections being put in place at completion.

We will keep you fully up to date on the passage of these proposed reforms, but if you have any questions in the meantime or would like one of our team to review your existing contractual protections, please let us know.

And if you have any questions about the proposals outlined above, or indeed any other employment or discrimination law queries, please feel free to get in touch with Jennifer Skeoch or Ross Gale.

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